Reopening the Economy is Showing Positive Results—But at What Cost?
While the easing of US economic lock-downs has generated an expected rebound in economic activity in May and June, the recent resurgence in corona-virus infections is likely to slow the pace of recovery in the second half of the year. The latest estimates are for GDP to decline 4.6% in 2020, slightly less than originally projected.
On the employment front, weekly new jobless claims are declining but are still in the 1.5 million range and could easily spike back up. Some states are acknowledging this by rolling back the reopening of restaurants, bars, and other businesses. Continuing claims are still running at about 18 million. While the graphs below show the recent improvements, they also illustrate how severe the unemployment situation still is compared to a few months ago before COVID-19 devastated the job markets.
Positive consumer and small business confidence readings remain fragile but hopeful that virus containment measures (plus the development of therapeutics and vaccines) will significantly improve the health outlook sooner rather than later. The “Recovery Tracker” graph (next below) shows the rebound in different facets of economic activity but also highlights the slowdown in its acceleration along with the recent deterioration of the health component. The second graph below shows the decline in activity that has been induced by a resurgence of the virus in some of the southern and western hot-spots in the country that reopened more aggressively. As we stated earlier, the extent to which this could slow growth in the months ahead will require further vigilance.
What About Financial Markets?
The S&P 500 dropped 34% from its February high to the low on March 23, and thereafter rebounded 42%. The Dow is lagging slightly while the NASDAQ is positive year to date. Stock markets will continue to be volatile, driven by expectations and perceptions about the impact of the corona-virus on the economy and on corporate earnings. While earnings projections for this year and next have stabilized lately, the first graph below shows how much profitability-forecasts declined over the past few months. The second graph below shows that 2021 earnings estimates are almost identical to what was attained last year.
With equity markets close to where they started the year, it raises the question if you are comfortable paying the same price now to own stocks based on very uncertain earnings almost 18 months in the future, compared to the profits those same companies actually earned in 2019. Even accounting for lower interest rates, this seems to be a much higher risk environment for equity exposure.
On the optimistic side of the ledger, US fiscal and monetary stimulus programs have totaled about $10 trillion so far in their combined potential effect—about 50% the size of the US economy. Additional governmental legislation is expected shortly. Also, Fed officials reiterate at every opportunity that they will do whatever it takes to mitigate the economic downturn and support the recovery. This unprecedented amount of backing by the US along with many governments and central banks around the world should help mitigate the size of any future price declines.
Lest we get myopic about concerns related to a corona-virus second wave, financial markets are also wrestling with the challenge of a sustained recovery in employment, the precarious state of US-China trade relations, and potentially negative tax and business repercussions that could follow the November elections.
While we are encouraged by the market’s rebound and the amount of governmental support for the markets, we remain cautious of potential future price declines caused by an overly optimistic view of the economic recovery and virus control. As a result, we have continued to follow a moderate approach in returning toward a neutral risk allocation while retaining flexibility to respond to further market volatility. To this end, we have made the following broad-based portfolio adjustments the prior quarter:
- As the Federal Reserve announces its intention to support prices in many of the fixed income markets, we liquidated our government bond holdings and reinvested the proceeds into a mix of high-quality corporate, mortgage-backed, and municipal bond funds. This was designed to capture higher yields as well as some modest price appreciation as these markets recovered to more “normal” prices.
- A few weeks after oil prices temporarily dipped below zero, we made a modest tactical (~1 to 2-year time horizon) investment into a high-quality energy and natural resource fund managed by Fidelity.
- On five different occasions we reallocated funds back into the equity markets using various vehicles.
- We created four new Structured Notes. These give us US and international equity exposure while having 10-15% downside protective buffers in the event stocks decline during the term of each note. One of these was created to replace a note we just built in March and had increased 16.9% in value. When markets increase this dramatically the downside buffer no longer gives much protection. By restructuring the note, we can “step up” the buffer to the current, higher price levels.
As always, we thank you for your continued trust and loyalty. If you have questions about your portfolio, we invite you to talk to your advisor. It is important to evaluate your specific strategy through the lens of your financial plan to ensure your investments remain congruent with the goals and objectives you intend for your assets.